Block muddies the waters on Olam

Renegade analyst Carson Block and his short-selling shop, Muddy Waters, is at it again as his battle with Singaporean soft commodities trading firm Olam International heats up. Block is notorious for identifying companies he suspects are either cooking the books or bamboozling investors with complex accounting, taking a short position and then going public with his findings in the hope that the broader investment community will adopt his view.

Block’s vindicated call last year that Toronto-listed Chinese timber company Sino Forest didn’t have as many trees as its books implied forced investors, and management of the firms he targeted, to take him seriously.

Last week, he revealed his latest target, Olam – a Singapore-listed trader of cocoa beans, coffee and soft commodities partly owned by state investment fund Temasek – by presenting his case against the company to a small audience at a conference in London. Block followed up his initial comments with a 133-page report.

The characteristically feisty document questioned Olam for some of its non-cash accounting items, its way of “snowballing" capital expenditure and for buying over-valued assets. Muddy Waters also said Olam would have to raise $S4.6 billion ($3.6 billion) in the next 12 months to remain solvent.

AFR
AFR

Olam has around $S3.8 billion of debt due in the coming 12 months, of which 73 per cent is in the form of bank loans, analysts at UBS said. The company counts
Australia and New Zealand Banking Group
and
National Australia Bank
among its lenders, according to broker reports and company filings. Neither ANZ nor NAB would provide comment on Olam.

Olam management has been on the front foot – and is suing Muddy Waters for libel.

On Thursday, CEO Sunny Verghese responded directly to the report by stating that the company has more than $S10 billion of liquidity to meet debt maturities, inducing a 3.3 per cent rally in the stock and an ever-so-mild rally in the bonds.

Mr Verghese added that he had “reached out to all" the firm’s counter-parties, of which none had pared back their support.

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Post Sino Forest, Muddy Waters targets have wised up. Block’s more recent targets have, at least for the time being, managed to fend off his attacks. Given the aggressive manner in which he takes on companies against which he has a financial bet, it’s natural the market scrutinise his calls.

Another sector of the investment community that has helped to fulfil this role are credit analysts. High-yield credit analysts that have covered Olam International are well aware of the risks posed by the company’s aggressive balance sheet. Olam’s debt to earnings ratio is 9.5 times, according to Barclays, and it has been free cash flow negative for three years. That ratio compares with 6.5 times debt to earnings of another Asian-based commodities firm Noble Group. Credit analysts have to maintain an ultra sceptical approach to analysing a company because unlike equity investors, they share none of the upside and all of the downside.

“Many of the [Muddy Waters} allegations are known to credit investors including the highly leveraged balance sheet, the significant capex commitments and refinancing needs," wrote Hong Kong-based UBS credit analyst Anna Ho.

The sales and trading desk credit analysts of Nomura, led by Pradeep Mohinani, have done extensive work on Olam, and were “better sellers of their bonds" before Muddy Waters made their allegations.

RUSH FOR CAPITAL

“While Olam may eventually deliver on the investments it has undertaken, we believe its strategy is very aggressive considering its very high leverage and the fact that a lot of its investments are still in the gestation period and yet to prove their worth," Nomura wrote on November 15, four days before Block’s London presentation.

In a note that followed Muddy Waters’ allegations, the Nomura analysts detailed many of their own concerns around the company’s liquidity, high cash burn, risky investments and debt covenant pressures. While economic growth has stagnated in the developed world, Asia continues to power ahead and more businesses in the region are hungry for capital to seize opportunities. As a result, there has been a proliferation of high-yield debt issuance from Asian companies.

But amid the rush for capital, greater vigilance is required from investors and analysts on the health of these companies and the viability of their funding programmes. Several credit analysts in the region are making a name for themselves in delving deep into balance sheets of firms, banks and sovereigns. Among them is Fitch Ratings’ China banking analyst, Charlene Chu, who has been dubbed the “Meredith Whitney of China" by one hedge fund for her work on the informal or “shadow" banking sector in the country.

In the case of Olam, which is proving to be a complex business, the absence of public credit ratings means the onus of understanding its balance sheet falls entirely on investors.

The battle between Muddy Waters and Olam is set to drag on and while the credibility and motives of short sellers will be questioned, in a broader sense they play a valuable role in keeping companies honest and forcing greater transparency.

Citi’s Singapore-based equity analysts identified a silver lining in the mess created by Muddy Waters in that the “clarifications have helped Olam’s stakeholders better understand Olam’s business".

The stock price and bond rates, however, imply stakeholders valued Olam more when they didn’t understand it.